Expenses used for PPP loan forgiveness: Deductible or not?

The Paycheck Protection Program (PPP), created as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, authorized loans to certain businesses affected by the COVID-19 pandemic. If businesses use their PPP loans for certain qualified business expenses, then some or all of the loan may be forgiven, subject to certain tests. CARES Act Section 1106(i) explicitly excludes the forgiveness of PPP loans from gross income.

While the CARES Act excludes the loan forgiveness from gross income, it does not specifically address whether the expenses used to achieve the loan forgiveness would continue to be deductible. On April 30, 2020, the IRS issued Notice 2020-32 to provide guidance regarding the deductibility for federal income tax purposes of certain otherwise deductible expenses incurred in a taxpayer’s trade or business that the taxpayer uses to support loan forgiveness. The notice states that no deduction is allowed under the Internal Revenue Code for an expense that is otherwise deductible if the payment of the expense results in forgiveness of a PPP loan because the income associated with the forgiveness is excluded from gross income for purposes of the Code under CARES Act Section 1106(i). The notice cites Sec. 265 as the specific disallowance provision and also notes that case law and published rulings would disallow the deduction because the taxpayer has a reasonable expectation of reimbursement of those amounts.

On Nov. 18, 2020, the IRS issued Rev. Rul. 2020-27, clarifying the tax year for which the deduction would be disallowed, and Rev. Proc. 2020-51, providing a safe harbor for taxpayers who did not claim deductions for expenses intended to be used for loan forgiveness but whose loan is not forgiven. Rev. Rul. 2020-27 holds that a taxpayer computing taxable income on the basis of a calendar year may not deduct eligible expenses in its 2020 tax year if, at the end of the tax year, the taxpayer has a reasonable expectation of reimbursement in the form of loan forgiveness on the basis of eligible expenses paid or incurred during the covered period. Rev. Proc. 2020-51 provides a safe harbor for taxpayers who paid these expenses, not claiming a deduction for such amounts, and in a subsequent year is informed that forgiveness of all or part of the loan is denied or decides not to apply for forgiveness. The safe harbor allows the borrower to deduct these expenses on an original or amended tax return for 2020 or a subsequent tax year and requires a specific statement to be attached to the income tax return on which the expenses are deducted.

In our opinion, Notice 2020-32 and Rev. Rul. 2020-27 are not a reasonable application of existing tax law. As such, Rev. Proc. 2020-51 is not needed. This article describes our position.